President Putin’s recent moves in the Middle East—to shore up Bashar al-Assad’s regime in Syria through deployment of combat aircraft, equipment, and manpower and build-out of air-, naval-, and ground-force bases, and the agreement in the last week with Iran, Iraq, and Syria on intelligence and security cooperation—could contribute to Russian efforts to combat the myriad negative pressures on Russia’s vital energy industry.

Live by Energy…

Energy is the foundation of Russia, its economy, its government, and its political system. Putin has highlighted on various occasions the contribution Russia’s mineral wealth, in particular oil and natural gas, must make for Russia to be able to sustain economic growth, promote industrial development, catch up with the developed economies, and modernize Russia’s military and military industry.

Even a casual glance at the IMF’s World Economic Outlook statistics for Russia shows the tight correlation since 1992 between GDP growth on the one hand and oil and gas output, exports, and prices on the other (economic series available here). According to the IMF’s 2015 Article IV Consultation-Press Release and Staff Report, published August 3, oil and natural gas exports constituted 65 percent of exports, 52 percent of the Federal government budget, and 14.5 percent of GDP in 2014. Including their domestic contribution, hydrocarbons represent ~30 percent of GDP.

While oil and natural gas are crucial to Russia, Russia’s crude and natural gas are crucial to its neighbors on the Eurasian landmass. Russia supplied about 30 percent (146.6 bcm) of Europe’s natural gas in 2014, and about 25 percent of its crude (3.5 mmbbl/day) in 2013. Russia’s oil and natural gas are also important to its Asian and Central Asian neighbors.

It is not only the commodities that make Russia crucial, but its massive land-based infrastructure for their distribution throughout the Eurasian landmass. As Tatiana Mitrova, head of the oil and gas department, Energy Research Institute, Russian Academy of Sciences, pointed out regarding natural gas in The Geopolitics of Russian Natural Gas:

“Russia has a unique transcontinental infrastructure in the heart of Eurasia (150,000 km of trunk pipelines), which also makes it a backbone of the evolving, huge Eurasian gas market (which could include Europe, North Africa, the Commonwealth of Independent States (CIS), Caspian Sea region, and Northeast Asia). Control over the transportation assets in this region together with vast gas reserves make Russia the key element of this new market.”

The land-based oil distribution network is smaller, but also important. The 4,000 km Druzhba pipeline delivers about 1 mmbbl/day of crude to Europe—about 30 percent of total shipments to Europe. In the Far East, Rosneft shipped 22.6 million tons of crude to China in 2014 through the East Siberian Pacific Ocean (ESPO) pipeline.

The Russian government continues to seek to extend and expand the natural gas distribution infrastructure—into Europe, with various proposed pipeline projects (Nord Stream 2, Turkish Stream 2, 3, and 4, South European Pipeline), and into China, with two large pipeline projects, Power of Siberia Pipeline (to supply China from East Siberia), and the proposed Altai pipeline (to supply China from West Siberia).

…Death by Energy

In the last few years, the threats to Russia’s energy industry have multiplied and intensified. They pose an existential threat to the industry and therefore to the Russian economy:

The revenues Russia can earn from its crude and natural gas exports face intense pressure. The Saudi decision to let the market set prices and to pursue market share, has led to steep declines in crude and petroleum product prices. The decision also has impacted natural gas export prices negatively, since, for Russia's long-term supply agreements, they wholly or partially are indexed to oil prices. The transition in Europe to hybrid natural gas pricing models (which take European spot hub prices into account) also has pressured natural gas pricing. (Natural gas data from Gazprom).

Adding to the revenue pain, natural gas export volumes have been falling, according to Gazprom (which has a monopoly on pipeline exports), as have domestic volumes within Russia:

Since these IMF projections are based on $60.1 and $65.8 per barrel prices in 2015 and 2016, oil export revenues will undershoot these pessimistic IMF projections, as crude prices are projected to stay below $60 through 2016 (EIA estimates for Brent are $54.07 and 58.57 in 2015 and 2016 respectively).

The U.S. and European Union’s decisions to impose—and maintain—sanctions on Russia after its invasion and annexation of Crimea and invasion and informal annexation eastern Ukraine will pile more pressure on the Russian energy industry. They include bans on financing for and the supply of critical equipment and technology to important Russian energy projects. Novatek and its partners Total and Chinese National Petroleum Company still lack $15 billion of the $27 billion needed to finance the Yamal LNG plant. Denis Khramov, Russia’s deputy Minister of Natural Resources, said September 28 at a conference in Russia’s Far East that Rosneft and Gazprom are delaying some offshore drilling by two to three years because of sanctions and low oil prices. The sanctions are also impeding Gazprom’s ability to develop the Chayandinskoye and Kovyktinskoye fields in eastern Siberia, from which it plans to supply natural gas to China under the bilateral $400 billion, thirty year deal signed in 2014.

Following the Russian invasion of Crimea and eastern Ukraine, The European Union is now even more determined to reduce its dependence on Russia for natural gas and to force Gazprom submit to EU competition rules. Europe has sought and continues to seek alternatives Russian natural gas (among them, U.S. LNG and Iranian pipeline and/or LNG). The European Commission, the European Union’s executive body, has refused to bless Gazprom’s proposed 55 bcm/year Nord Stream 2 natural gas pipeline project, citing existing surplus Gazprom pipeline capacity into Europe and insufficient future demand for Russian natural gas. Also, the EU Commission in April charged Gazprom with violating the EU’s anti-trust laws for anti-competitive practices and unfair pricing in Central and Eastern Europe. If found guilty, Gazprom could face substantial fines of around $1 billion. Even if Gazprom avoids fines and manages to reach a settlement with the EU, as it hopes to do, its European market share and pricing will remain under pressure into the future.

The emergence of the U.S., along with Canada, as powerful crude, NGL, and natural gas producers is also a major concern for the Russian economy. This has transformed the U.S. from a market for Russian crude and natural gas (via LNG) to a global competitor. If, as seems increasingly likely, the ban on crude exports is lifted, U.S. crude will compete with Russian crude in several key markets. It would also force foreign suppliers to seek other markets for all or part of the exports they previously sent to the U.S. This in turn would intensify competition among these crude exporting countries for share in those markets. In regard to natural gas, its explosive output growth in the U.S. undercut Gazprom’s rationale for its Baltic LNG project (10 mtpa), turned the U.S. into a major (potential) LNG competitor in global LNG import markets, and, via the U.S. toll- and Henry Hub- pricing model, weakened Gazprom’s ability to insist on oil-indexed, long-term contracts.

Saving Russian Energy (and Russia) through the Middle East?

Putin’s moves in the Middle East could help Russia address the impact of these threats to the Russian energy industry. They potentially enhance the attractiveness of Russian crude and natural gas supplies compared to those from Saudi Arabia and its Gulf Arab allies.

In the selection of crude and natural gas suppliers, security is a key consideration for importers. Wary of U.S. naval power, the Chinese, for example, prefer pipeline natural gas supplies over seaborne LNG supplies. Importers therefore must take into consideration the potential threats to transport. In this critical area, Russia enjoys a decided advantage over Saudi Arabia and the Gulf Arab producers, which depend on sea transport through the Persian Gulf and the Red Sea to ship their oil and LNG.

Each of the three routes from these two bodies of water passes through a “choke point” (from the Red Sea, through the Suez Canal to Europe and through the Mandeb Strait to Asia, from the Persian Gulf through the Strait of Hormuz). By adding an airbase to their military presence in Syria, the Russians—coordinating with Iran, Syrian President Assad, and eventually possibly Iraq—would have the capability to disrupt shipments from Persian Gulf and Red Sea terminals.

Russia’s export channels are less susceptible to disruption. With the exception of LNG exports to Asia from Sakhalin, Russia sends natural gas to its customers via pipeline. About 70 percent of Russia’s seaborne oil exports are susceptible to choke points (shipments from two ports on the Gulf of Finland through the Baltic Sea to the Atlantic and one port on the Black Sea through the Turkish Strait/Bosporus to the Mediterranean), while 30 percent are not (pipeline shipments to Europe and ESPO pipeline shipments to the port of Primorsk near Vladivostok).

Putin’s moves also are strengthening Russia’s influence with OPEC. Russia already has extensive and close ties with Iran and Venezuela, and is now laying the basis for such ties with Iraq. Putin has aligned Russia with OPEC’s have-nots—the members lacking financial resources to withstand low crude prices for an extended period and that have objected to Saudi policies (Iran, Iraq, Angola, Nigeria, Libya, Algeria, Ecuador, and Venezuela)—against the haves (Saudi Arabia, Kuwait, the UAE, and Qatar). He has continually supported Venezuelan President Maduro’s calls for an emergency OPEC meeting on prices and his efforts to persuade Saudi Arabia to reverse its policy. Most recently, in the beginning of September, Putin told Maduro that the two countries “must team up to shore up oil prices”.

In addition, Russia’s deputy prime minister in charge of energy policy, Arkady Dvorkovich, in the beginning of September made comments that, in tone and substance, mocked Saudi policy, saying that “OPEC producers are suffering the ricochet effects of their attempt to flush out rivals by flooding the world with excess output,” expressing doubt that OPEC members “really want to live with low oil prices for a long time,” and implying that Saudi policy is irrational.

Indeed, Russia can be seen as maneuvering to split OPEC into two blocs, with Russia, although not a member, persuading the “Russian bloc” to isolate Saudi Arabia and the Gulf Arab OPEC members within OPEC. This might persuade the Saudis to seek a compromise with the have nots.

A strategic alliance with Iran and Iraq offers Putin two more potential avenues to pressure the Saudis. They can test Saudi determination to defend their market share at any price and its wherewithal financially to do so. Iran claims it can raise crude output by one million barrels within six or so months of the lifting of sanctions. The Saudis may be calculating that Iran must first rehabilitate its oil fields and that Iran, cash poor, cannot do so quickly. If this is the case, Russia could step in, offer Iran financing, and force the Saudis to contemplate prices staying lower longer than they anticipated and therefore continuing pressure on their economy.

Russia also could cooperate with Iran and Iraq to take market share from Saudi Arabia in the vital Chinese market. As a recent Bloomberg article pointed out, Saudi Arabia, Iran, Russia, Iraq and other countries are vying intensely for sales to China, the second largest import market and the major source of demand growth in coming years. Coordinating their pricing and consistently offering the Chinese prices below the Saudi price, they could seek to win market share. Such a price war would pressure the competitors’ currencies.

Since the Russians allow the Ruble to float, Iran maintains an informal and unofficial peg for its Rial to the US$, and Iraq has indicated it is willing to adjust its peg if necessary, while the Saudis are committed to the Riyal’s peg to the US$, Russia, Iran, and Iraq would have any advantage over Saudi Arabia. To the extent that Iran and Iraq allowed their currencies to adjust, Russian, Iranian, and Iraqi revenues in local currency terms would not decline as much as Saudi revenues fixed in US$ (and might even increase) as their currencies depreciated.

Results

Each of these opportunities offers the possibility to address the pressures on the Russian energy industry. However, Putin will have to play his cards carefully. Played heavy-handedly, he could intensify fears in Europe of excessive dependence on Russian energy supplies and awaken such fears in China. This could lead the Europeans and Chinese to search for other suppliers. In addition, mismanaged confrontation with the U.S. and Europe in and over Syria could lead to broadening and strengthening of economic and financial sanctions. Moreover, neither Iran nor Iraq will want to become overly dependent on Russia, which lacks the resources they need develop their energy industries.

Finally, the opportunities assume Putin’s gambits in Syria and with Syria, Iran, and Iraq in intelligence and security cooperation will succeed. And this, given the Soviet experience in Afghanistan and Putin’s experience in eastern Ukraine, is far from certain.

Dalan McEndree has a BA in history, MA in European History, M.Phil. in Russian and Soviet history, Soviet economics, and International economics, and MBA in finance and marketing. His career has focused on the Soviet Union and Russia, and has included fifteen years in Russia as a US diplomat, in business, working both for international and Russian businesses, and in consulting. He is also the author of several self-published Russia-focused murder mysteries, and two satires.

Comments

I do not see at all how Russia can destroy OPEC by attacking AQ and IS in Syria. But it will certainly boost Putin's popularity in the West that he now focus on attacking AQ and IS instead of attacking Ukraine. Forget the nonsense talk about the Free Syrian Army. It does not exist apart from a few hundred people that are scared and totally irrelevant for what is happening on the ground. The only moderate party left in Syria is the Kurds and they are being bombed by Turkey's air force.

Also the Iraqi army does not dare to confront IS in Iraq despite outnumbering them by one to ten and getting massive air support from the West. So the Middle East will be destroyed in the coming years by AQ and IS and Europe needs to start now building impenetrable borders to keep the refugees and the migrants out. We are too few people in Europe to handle the massive number of refugees and migrants that are about to flow from countries that are taken over or destabilized by IS or AQ. They are already coming by the 1 to 2 million per year and it will raise dramatically in the next few years when the entire Middle East collapses. Sorry for this bleak view of the future but I see noting good when I look at the mess in the Middle East. OPEC will be destroyed by AQ and IS and Russia's actions in Syria, if anything, is just delaying that outcome a little bit.

Don't be so naive and believe what Putin is talking about. His sole purpose is to retain a feeble foothold in Syria and increase his influence. The Russians got their ass kicked out of Egypt and don't want to repeat such a bleak point in history. His intention is not to help Assad but more so to help himself.
Up to now, Russian attacks were aimed at Syrian rebels and not IS mongrels. Eventually he'll turn his attention to the IS as well but for the present, his main focus is turned to the Syrian rebels.
In this manner, he can create social problems for Europe whilst flooding the continent with refugees and relieve the pressure on Assad. This is a twisted bargaining point to gain removal or relief of the European sanctions which are really frustrating and hurting the Russian economy.
The IS is also a remote problem for Russia and, in due time, Putin will certainly focus his attention on them as well. But for the time being, one step at a time.

there are 750 million people in Europe, if there are 1 million immigrants coming in a year, that is only 0.13%. Certainly we can help the people that have to flee their homes from the terror of AQ and IS.

What really needs to stop is this bullsnazzle over oil. But that is why we are here on GCC

Who is being naive? Russia is bombing Raqqa and Palmyra, pure IS strongholds. What rebels? The only fighting forces of relevance on the ground in Syria today is Assad, the Kurds, IS and AQ, you know, the guys responsible for 9/11. Assad will fall if Russia does not step in. That will create millions of refugees as AQ and IS will kill and enslave anybody who does not share their particular view of religion. Assad's fall would also give AQ and IS more resources (cities and weapons) to enlarge their war against Jordan and Lebanon. They will fall next. Putin is actually saving EU from more refugees. He is doing EU a huge favour by buying us some time to put up those impenetrable fences before we are overrun by a flood of people with a culture that will divide and split Europe and most likely lay the seeds to civil war in Europe as well. I do not like Assad or Putin for the matter but they are saints compared to IS or AQ.

Communism fell about 1989. There has been plenty of time for Russia to grow into a strong economy. They have many resources and generally their people are smart and work. However, Russian are seriously corrupt and they have wasted many years favoring the Oligarchs. Their mineral wealth is the only thing now that saves them from complete collapse, but it is not enough to bring them into the future when they have no system of government or enterprise that allows for merit based growth. The US if left to the Oligarchs/corporations would be almost exactly in the same boat as Russia where only the rich have any freedom. Certainly our corporation and wealthy would like to be kings, but our constitution, which they hate because it does preserve some freedom, prevents them from easily bringing back the serfs and kings that have mostly been the case for most of history. They will still try and if they succeed, we will be just like Russia, a fake democracy with just a few owners who call all the shot and who are essential our kings. Anyway, Russia is weak because they believe in corrupt power and criminality. No amount of rigging of the energy industry will save them from their greatest flaw. Anyone who tries to make oil high priced again will only assure it's death through competition with alternatives. Why the heck do you think the price is low now, it is because the alternatives are too strong and many desire their expansion to significant levels.

Last time I checked the news 1.5 million migrants and refugees were heading to Germany in 2015 (a country with an 80 million population). Next year it will be 2 million and so forth and then we will have civil war like in Yugoslavia just on a much bigger scale this time. The world is already at war with religious extremists. About 100k are killed globally every year now. Nobody can really stop it from escalating further because that would require drastic measures that are at odds with human rights.

The inconvenient truth about our democracy is that Nazi Germany was only stopped when the free world started to flatten large German cities by carpet bombing them in order to degrade their ability to sustain the German army with new soldiers and weapons. Same with Japan that was only stopped when we erased two cities and threatened to erase many more if they did not capitulate immediately and without conditions. That is how the democracy of the free world was saved half a century ago. I do certainly not hope we will see a repeat of those methods but it cannot be ruled out either. It may actually come to that one day because the alternative will be even worse. The trajectory certainly does not look good. More war is coming for sure and it is going to get much more ugly and the refugees and migrant numbers will escalate.

This is quite scary, and we should parse everything this author says. After years of brainwashing over "Big Oil", it is none other than the Gendarme of the World that is playing the game. For the most astute of reasons.

Since the West is used to reading Russia cryptologically and with ignorant optimism, Putin can commit "evil deeds" as Stalin once ruminated, to buy time for and acceptance of his international positions. To bargain all sides of the fence, siding with both peace and war to gain Western acceptance of Russian bargaining supremacy, is as old as Lenin, who sued for peace and then restarted war to spread international revolution at the most inopportune time for young Bolshevist Russia.

The end of Putin's bargaining will make for some strange bedfellows. Israel will see an unprecedented period of peace as Hezbollah, Assad, and Hamas struggle among themselves. Turkey will gain symbolic mastery over ISIS which will retain territory, while Putin because symbolic arbiter on behalf of the Kurds, to marginalize Erdogan, who will receive no sympathy from the West. And Iraq could care less about a defacto expanded Kurdish state. Why should Iran and Russia put in more arms than they must to block the US and make a point over Saudi.

Sooner or later Saudi will accede to oil price increases which will benefit Iranian controlled areas of Iraq. You can bet that every neighbor from Jordan to Turkey will accede to oil smuggling which did quite well under Saddam despite the Oil for Food Sanctions (which the Assad family did much to implement and legitimize, while turning Syria into a purported ally of the Bushes). Like Russia, Turkey too will have to prop up its economy through such subterfuge and tacit cooperation. And China, to distract from its failing economy, will play anti-Americanism and the Shanghai accord to its limit, stressing economic cooperation within the region and long-term oil contracts, with primarily high-grade Iraqi oil, protected by Tehran (do you honestly believe an oil man would prefer instead to drill Iranian ultra-heavy crude with outdated technology and a bad business environment whenBaghdad is much more motivated and can outproduce Saudi?)

Obama and Kerry have committed an unbelievable blunder, abetted I believe, by Mitch McConnell ( who would not submit the Iran arms control treaty to a proper vote) and the US Chamber of Commerce, which will devote $300 mil of crony money to defeat Tea Party Republicans, and dreams of mullahs driving Ford Explorers. Heads will roll.

PS I expect the unexpected in the form of higher interest rates as oil prices go up, confidence decreases, and we at least are lectured that 70's inflation will rear its ugly head again.

I tend to agree with Henrik. Looks someone who wants to cause problems in Europe (short and long term) is organizing (and financing) the mass influx of refugees there. Soros foundation is heavily involved. Interestingly they don't migrate to neighboring very rich Muslim countries (Saudi Arabia, Emirates) which are culturally much closer to almost 100% Muslim migrants.

To understand the politics of oil, this book is a must read, now free:
http://www.takeoverworld.info/pdf/Engdahl__Century_of_War_book.pdf
The author is American professor William Engdahl.

BTW Crimea has been part of Russia longer than Texas, California, Arizona, Nevada, Utah, Hawaii and Alaska have been part of the USA. Communists took it away from Russia by a decree. Similar thing with Ukraine that has been for the most part integral part of Russia for one thousand years. Almost the same people, culture, language. It was Lenin communists who gave statehood to Ukraine.

What's this assertion that Russia invaded Crimea and eastern Ukraine? I don't recall the UN taking such a position and that's because the endogenous people of those regions are predominantly ethnic speaking Russians. They effectively claimed home rule and why shouldn't they after the neo-nazi Maiden thugs pushed for ethnic and political cleansing. What major economic player isn't playing the oil game right now. Since the US tight oil industry went tits up they have been eager to secure future oil supplies by allowing IS to fight a proxy war against Al-Assad in Syria. It doesn't fool anyone. When the US petro-dollar gets seriously devalued I wouldn't want to have my life savings in any of their banks - they'll be gone!

Well Harvey, this means the US actually has the ace in the hole. Resumption of production of these domestic fuels will skyrocket the value of the dollar, and, by the way, cripple the Chinese Yuan. A country cannot simply dump cheap goods on the US and maintain imports and general production at purchase power parity (PPP). In other words, a Big Mac costs roughly the same in China as it does in the US. Suppressing Chinese wages will not produce more Big Macs at globally competitive rates. It just means fewer Big Macs will be sold in China.

I mentioned the bit about the Fed because raising the Fed rate a quarter point or two will cause more capital flight via Hong Kong. Chairman Hsi cannot stem this flight any more than Nixon could. Yet many economists believe that since the US is a wealthier and less energy dependent economy than it was in the 70's, will will weather an oil price increase much more handily than virtually any country on earth.

Russia has already made noises about moving to a gold standard, which is quite sensible, given the fact that it produces it, and has a very unstable economy with insecure sources of credit. Which is not to say some Sino-Russian consortium will bring the West to its knees. More likely China will be required to pay for oil in gold which will one way or another be funnelled to Moscow, to stabilise the Ruble and avoid making Putin look like a captive to the self-described largest economy in the world which will gobble up Siberia pretty soon.

Nobody really knows what Russia will do next to regain more international highlight and prestige. It could blackmail EU by restricting the supply of Oil and NG but that could reduce essential export required to maintain the Russia economy afloat.

Secondly, the above restrictions could convince EU to accelerate transition to clean alternative energy sources and to put an end to (or greatly reduce) Russian Oil and NG imports.

A combined effort by USA/Canada/Mexico could make North America self-sufficient with fossil fuels and become NET exporters by 2020 or so.